Retail Buying Opportunities Ahead

The combined effect of the credit crunch and curtailed expansion plans by retailers will bring enticing retail property offerings to market in 2008, researchers predict. Lackluster asset sales in January, however, confirm that buyers remain rooted to the sidelines.

“It’s a very difficult selling market right now,” says Bernie Haddigan, a managing director at Marcus & Millichap and director of the company’s national retail group.

Some $2.2 billion in retail properties changed hands in January, the lowest monthly volume in four years, according to Real Capital Analytics, which tracks deals of $5 million or more. Average capitalization rates, or initial rates of return based on the purchase price, climbed eight basis points from the previous month to 6.79%.

Would-be sellers of retail properties face a number of challenges. For one, the credit crunch limited the amount leveraged buyers are able to pay on acquisitions, sparking an ongoing repricing of assets. Second, buyers still in the market are taking a harder look at asset quality, leasing and rental income. That’s bad timing for sellers, who are losing the upper hand in lease negotiations due to changing supply and demand dynamics.

Construction will add 125 million sq. ft. to the national retail inventory this year, down from 145 million sq. ft. built in 2007, according to Marcus & Millichap. Much of that space under development is pre-leased, with big-box retail and build-to-suit accounting for 40% of construction. Unfortunately for some property owners, demand is declining as retailers pull back on expansion plans.

“Wal-Mart in 2007 as well as Target cut their expansions by probably 50% over the previous year, and they’re actually slowing that pace down a bit,” Haddigan says. “Sears and a number of the retailers, in the short run, aren’t doing any expansion.”

Nationwide, retail vacancy rates will climb 50 basis points to 10.2% by the end of 2008, according to projections Marcus & Millichap published in its 2008 National Retail Report. Rent will grow 2.6% to average $20 per sq. ft., but weakened market conditions will compel landlords to offer concessions that temper those gains to 2% effective rent growth.

A good place to watch for buying opportunities will be in secondary and tertiary markets, Haddigan says. In the flight to quality that typically occurs during times of trouble, retailers will focus their growth on major cities and the newest, best-quality properties. That means the greatest vacancy increases and price declines will occur at older properties and in secondary and tertiary markets.

Cap rates in those secondary and tertiary markets could rise 100 basis points this year, Marcus & Millichap predicts. “From the summer of 2007 through the end of this year, I wouldn’t be surprised if cap rates increase 125 basis points on the lower end of the market,” Haddigan says.

Nationally, cap rates have risen on retail properties since last fall. In the fourth quarter, average cap rates climbed to 7.2% from about 7.08% in the third quarter, according to research company Reis Inc.

So far, few buyers have taken the plunge to buy assets at a time when property pricing is still in flux and the economy may plunge closer to recession. “Uncertainty over economic growth has replaced the credit crunch as the major driver of the continuing slowdown in property sales,” Real Capital Analytics researchers wrote this week in that company’s Capital Trends Monthly report, published Wednesday.

Haddigan expects buying opportunities to offer a bright spot in the current market turmoil, and those opportunities will grow more numerous as the year progresses. “The opportunities for buying better yields are going to be there,” he says. “It’s probably going to be one of the best buying markets we’ve seen in the last 10 years.”